Tips and Traps for Federal Student Loan Consolidation and Refinance

I thought I’d take a few minutes to write a follow up to Jeff Gitlen’s informative piece on consolidation of federal student loans over on LendEDU.com.

As a student loan attorney, we have learned several tricks to take advantage of ways to reduce student loan debt while avoiding the traps in consolidation. Consolidation is often misunderstood as a way to reduce interest rates. Jeff emphasizes that this is not accurate, rather the loans remain at a market weighted average of what they were before the consolidation. But it is much more convenient to have one loan, with one payment and one servicer. Not only does it makes payment easier, it makes enrollment in income driven plans much simpler. Same with the annual certification of your proof of income – only one place to send your proof of income. One payment. Nice and simple.

But consolidation is much much more. You can actually change your loan type through a consolidation. Did you know that prior to 2010, 80% of all federal loans were the older Family Federal Education Loans (FFEL). And importantly, FFEL loans are ineligiblefor Public Service Loan Forgiveness. I know of LOT of people who didn’t know this and have loans outstanding from prior to 2010 – and they aren’t getting the relief Congress intended through the PSLF – people who are counting on their loans being forgiven after 10 years of public service. Consolidation of the FFEL loans to Direct loans would have fixed this problem that we’re now seeing in droves. A recent GAO report shows only 55 borrowers have qualified for PSLF to date due in large part to having the wrong loan type or in the wrong payment plan. Read about this more in this Student Loan Nightmare story focusing on two of our PSLF clients by ABC Action News.

How about something simple like qualifying for the lowest 10% income REPAYE program. Again, you have to have Direct loans. But prior to 2010, the vast majority of loans were the older FFEL loans. How do you convert them to Direct? You consolidate. Taking advantage of Repaye rather than the older IBR program can shave $100 – $300 or more from your payment for a middle income wage earner.

Consolidation is also one of only two ways to cure a default. This would avoid garnishment, social security offsets and income tax refund intercepts. You can consolidate FFEL loans with a Direct loan and use this to cure a default provided there is not a wage garnishment order in place already.

By the way, there are no time restrictions of six months after graduation to use consolidation in many of the situations I’ve outlined above.

Another way consolidation can vastly reduce payment plans is if you have Parent Plus Loans. I’ve heard from many borrowers who were misled when they were informed that their loans did not qualify for income driven plans with debt forgiveness. While that may be technically true, a more complete answer is that the borrower could have changed their loan type to fix that problem. The older loans can be consolidated to a new Direct Parent Plus Loan which is now eligible for an income driven plan — ICR to be specific.

One of the lesser known traps for the unwary is always avoid consolidating a Parent Plus loan with your own loans as all of the loans will be tainted with the Parent Plus loans. What does this mean? Well, it means that while you’ve made things better for the Parent Plus loans that can now go on ICR, you’ve made things worse for your own loans which are no longer eligible for IBR or Repaye which are superior programs.

And refinance of student loans is something all together different from consolidation. Basically, you are seeking a new loan with reduced interest and different payment terms. That can be perfect for the right borrowers. But there are pitfalls there too — if you ever become disabled, or need an income driven plan with debt forgiveness, you are giving up those important federal rights if you refinance to a private loan. Again, for the right individual it still may make sense – the average interest rate for federal loans is 6.8% which is pretty high in today’s market. Much better than the 12% I saw back when I graduated law school, but still when you can get a second mortgage for 2-3% today, it’s high. If you have strong income and perhaps a backup disability insurance policy, then refinance may be the way to go to save money.

So bottom line what does all this mean? In my opinion, the entire student loan system is way too complex, and not at all transparent. I guess that is good for attorneys like me who have carved out a niche practice designed to “make student loans go way”.

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